In principle, taxing income from labour and capital equally might appear to be fairer, simpler, and more efficient. In practice, it would almost certainly be none of these things.
Wes Streeting has proposed a “wealth tax that works” as part of his Labour leadership pitch, by equalising capital gains tax (CGT) with income tax. Some variation of this idea has been popular on the left for some time (see, for example, this 2022 piece by Dan Neidle, and his follow up from 2024). It would also doubtless poll well with the general public. But would this tax change actually “work”, as intended?
In a nutshell, Capital Gains Tax (CGT) is a tax on the profit made when someone sells an asset that has increased in value. There are some exceptions, notably for primary residences.
Crucially, CGT is typically levied at 24% for a higher or additional rate taxpayer, so substantially lower than the corresponding rates of income tax (40% and 45% respectively). A basic rate taxpayer would typical pay 18% (compared to 20%).
This seems like an anomaly. And at first sight, there is a strong case for treating income from labour and from capital equally. This might be fairer, simpler, and more efficient.
Indeed, economists generally like the principle of “tax neutrality”, which means that similar activities (or sources of income) should be taxed in the same way. This should minimise the risk that the tax system distorts the choices that are made and it should also maximise the revenues that are raised.
The reality, though, is much more complicated.
For a start, the problem of “double taxation” means that equalising the rates of CGT and income tax would not necessarily be fairer. This is not because the income used to buy assets will already have been taxed; CGT only applies to the gain on those assets, not the value of the original investment.
Instead, the point here is that the capital gain itself may already have been taxed. This, for example, is why dividend income is generally taxed at a lower rate than employment income, because dividends come from profits which are also liable to corporation tax.
Similarly, if you buy shares in a company and the value of those shares rises because the company is expected to be more profitable or pay higher dividends, these higher profits or dividends will also be taxed separately.
The upshot is that applying the principle of tax neutrality (or, if you prefer, “fairness”) would mean that CGT should be set at a lower rate on gains which might already be subject to other taxes, now or in the future, so that the combined rate of all taxes is the same as that on alternative forms of income.
The “tax simplification” argument may not work, either. Income from capital gains tends to be lumpier than income than employment, so fairness requires some way to smooth the taxable gains over time. The tax should also only apply to real gains, so fairness would require some form of indexation to strip out the impact of inflation.
Moreover, even Wes Streeting has accepted that “genuine” entrepreneurs should pay lower rates of CGT, which could make the system even more complicated. It makes more sense to focus HMRC’s efforts on ensuring that employment income is not disguised as capital gains, rather than second-guessing who is a “genuine” entrepreneur and who is not.
Finally, equalising CGT and income tax may not be efficient, either in terms of raising revenue or the wider impact that equalisation may have on the economy.
Decisions would still be distorted, just in different ways. For example, people would have a bigger incentive to hold on to assets rather than pay tax on them, or they might rush to dump assets in anticipation of future tax increases.
Income from capital also tends to be riskier than income from employment. If the two are taxed equally, this would create a disincentive to invest, or to start a business.
For these and many other reasons, the revenue to be gained from raising CGT is relatively uncertain – a point repeatedly stressed by the OBR. Indeed, analysis by many independent organisations suggests that an increase in CGT could actually reduce revenues, once the behavioural effects are taken into account.
Most strikingly, HRMC’s own ready reckoner shows that increasing the higher CGT rate by 10 percentage points would cost the Exchequer £2.1 billion in 2027-28, rising to £3.6 billion in 2028-29. On plausible assumptions, equalising CGT across the board at the current rates of income tax could reduce tax revenues by as much as £10 billion a year.
This proposal could only make a little more sense if part of a wider package of reforms of the tax system, perhaps including reductions in income tax (in other words, meeting somewhere in the middle of the current rates). This is what some of the more sensible advocates of equalisation have in mind, but this would still only deal with some of the objections. As it stands, the UK already raises more from wealth-related taxes than any other OECD economy.
Of course, none of this may matter during a Labour leadership campaign. The calls to equalise CGT and income tax are part of a vote-winning agenda based on vibes rather than evidence, with little thought to the wider fiscal and economic consequences.
The current CGT regime is crying out for reform, with a myriad of different rates, allowances and exemptions, and messy interactions with other taxes (notably inheritance tax). But raising the top rate of CGT from 24% to 40%, or 45%, would be another hammer blow to investment in the UK.
You can follow me on X (formerly Twitter) @julianhjessop and on Bluesky.
I also post regularly on Substack.
Plain-speaking Economics 